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Sunday, May 20, 2012 09:10

What is quantitative easing and will it help our housing market?

Despite the economy having grown by just 0.1% in the second quarter of the year, the Bank of England has chosen to keep the base rate on hold at 0.5% again. It is now over two-and-a-half years since the base rate dropped to its current level, but the Bank clearly does not feel that now is the time to increase the burden on struggling borrowers - despite the nation's savers suffering. Instead, it intends to try to boost the economy by purchasing bonds worth £75 billion - a policy known as quantitative easing (QE). But just what is QE? And how can it help to jumpstart the economy? The experts at www.moneysupermarket.com explain what you need to know... How does QE work? QE is an unconventional monetary policy used by central banks such as the Bank of England to ease monetary conditions and aid economic recovery. It is used as a "last resort" to increase the supply of money available when interest rates are either at or close to 0% - as they are at the moment - and cannot therefore be further reduced to give the economy a lift. It involves the bank spending its own money on bonds, usually issued by the government of the country in which it is based. For the Bank of England, this would therefore be UK government bonds. Sometimes referred to as the "printing" of electronic money, QE hit the headlines in 2008 when the US central bank spent more than $1.5 trillion (£1 trillion) buying bonds with money that it, in effect, created on its own account. The Bank of England has also done it before, spending about £165 billion on UK government bonds in 2009, and increasing this amount to £200 billion last year. It is this amount that has now been raised to £275 billion. The aim is to increase demand for bonds, which in turn lowers the yield, bringing down long-term interest rates and making borrowing cheaper. How does that help? The availability of cheap money helps to boost equity prices and supports the housing market. The stock market likes listed companies having access to cheap credit, leading to higher valuations, and cheaper mortgages make it easier for people to get on to the housing ladder or move to more expensive properties. Both the stock market and the housing market should therefore benefit from QE. However, the main aim of this round of QE, announced last month by Chancellor George Osborne and confirmed by the Bank of England today, is to improve the ability of small businesses - many of which have struggled in the downturn - to borrow. Why do we need another round of QE? The government's cost-cutting measures have proved a bitter pill for cash-strapped consumers to swallow. Economic growth is almost non-existent, the housing market is struggling and the stock market has been thrown into turmoil by global events. Smaller companies, which are vital to economic growth, are also finding it hard to get their hands on the cash they need to succeed and expand. The Bank of England is therefore hoping that a new round of QE will help to improve the situation and get the economy back on track. What are the risks? Some economists argue that "printing" money always leads to higher inflation. This could prove problematic as the rate of inflation in the UK is already at 4.5% - more than double the Bank of England's target of 2%. However, fans of QE believe that the sophisticated purchase and re-sale of government bonds can be done in a way that prevents inflation. Have your say on this story using the comment section below

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